Not all small businesses are created equally. The way your business entity is structured makes a difference in the way it will be taxed, and the rate you will pay. Recognizing the major differences between these structures and tax classifications is the first step in understanding the federal tax obligations for your small business.
The majority of small businesses do not have to pay corporate taxes because profits or dividends pass to their owners and shareholders, and are taxed under the individual income tax. S-corporations, sole proprietorships, partnerships and LLCs are classified as pass-through businesses.
In a C-corporation, which is the default corporate organization under the rules of the IRS, the assets of the business are taxed separately from the personal assets of its owners and shareholders. Shareholders pay taxes on any income dividends the business makes.
To become an S-corporation, a business must first be registered as a C-corporation or an LLC. In addition to adhering to a number of other rules, an S-corporation must have a board of directors, and is limited to a maximum of 100 shareholders. S-corporations aren’t required to pay federal corporate income tax, but they must file a Form 1120-S tax return.
Not all small business owners choose to incorporate. While C- and S- corporations must file articles of incorporation when they establish their business, a sole proprietorship doesn’t require them. There is no need to file a separate tax return for this type of entity; owners report business profits and losses on their personal tax return.
If you are a sole proprietorship, a shareholder in an S-corporation, or a partner in a formal business partnership you may be able to lower your taxable income through the Qualified Business Income (QBI) deduction. You may be able to deduct up to 20% off your business’s income before taxes, so be sure to ask your tax advisor if you are eligible for the break.
Tax Schedules for Your Small Business
A tax schedule provides the current tax rates for different income levels, and for the circumstances under which your business will be taxed. Schedules are also called tax rate sheets or rate schedules.
Schedule C for Profits and Losses
Sole proprietorships will need to file Schedule C with their tax return. Schedule C details the profits and losses of your business.
You must report your taxable income whether your small business is incorporated or not. If you are an independent contractor, freelancer, if you are self-employed in a side job, or have another activity that you make money on regularly, you will need to file Schedule C.
Schedule SE for Self-Employment Tax
Business owners that are not incorporated and make more than $400 from their business will likely have to pay the self-employment tax on the profits of their business to cover the costs of Social Security and Medicare. If you work for an employer, these taxes are withheld from your paycheck. For example, if you work for a company and freelance on the side, your employer will deduct payroll taxes (FICA) from your earnings, and you may have to pay tax on additional income that you make.
The current self-employment tax rate is 15.3%. However, you can deduct the employer-equivalent portion of your self-employment tax from your adjusted gross income. Remember that this deduction only affects your income tax, not your net earnings. You’ll use Schedule SE to determine the amount of self-employment tax you owe for that tax year.
Because they are self-employed, small business owners are also allowed to deduct the cost of health insurance.
Filing Your Tax Return
Unlike large corporations, sole proprietors don’t have separate due dates for filing their tax returns. You can file your taxes by mail or online just as you would your individual taxes; you must file your returns by April 15th or request an extension. Be aware that while an extension gives you six more months to file your return, you are still obligated to pay your taxes by the original due date. An extension gives you another six additional months to file your taxes, but not another six months to pay them.
Small businesses owners may need to file quarterly estimated tax payments to avoid penalties for underpayment. If you pay through quarterly estimated tax payments the 110% of the tax you incurred in the prior year, or pay at least 90% of your tax bill for the current year, you will not be subjected to underpayment penalties.
Should You Hire a Tax Preparer?
While not every business needs a professional to help them prepare their taxes, a tax preparer can ensure all of your information is correct, that you pay the appropriate taxes and benefit from the deductions that may apply to your business, and save you time and stress when filing your taxes. Find out more about our professional tax preparation services for small businesses by contacting Scharf Pera & Co., PLLC today.